variations on growth investing

While I’m on the topic of investment styles, I figure I should say something about growth investing.

I started out as a value investor, concentrating on US companies. After a few years as a securities analyst, I began assisting a superb value investor who was running a short portfolio, again all US. A couple of years later, I changed jobs and started working as a portfolio manager in smaller Pacific Basin markets. There, I was immediately attracted to smaller cap stocks, which at that time had the unusual combination of the best business models, the fastest growth and the lowest PEs in their markets. What they didn’t have was a lot of market visibility, partly because they were so small and partly because the markets I was working in, like Australia and Hong Kong, were not very highly developed.

Yes, I continued to find stodgy old conglomerates where enormous value could be created by breaking them up and selling the pieces one by one, and others where an infusion of competent management could dramatically reverse declining fortunes. But I became more and more impressed by the raw earnings power of dynamic young firms. It was only when I was describing my investment process in an interview for another job that I realized I was no longer a value investor. I had become a growth investor instead!

My experience is that there’s a lot of confusion about what growth investing is. In a sense, this confusion is aided and abetted by us growth investors ourselves, since no one wants to give away professional secrets, especially while he’s still working.

For example, the media talk about momentum investing, meaning buying stocks based solely on the fact that they’re currently outperforming the market. This is an old offshoot of technical analysis, however, and has nothing to do with growth investing.

Then there’s “pure” growth investing, as practiced by the ill-fated Janus group in the 1990s. Here the investor (that’s probably not the right descriptive) buys stocks based on accelerating sales and earnings, but without regard to price. But doing so completely disregards a growth investor’s greatest challenge–knowing when to sell. To my mind, this is pure speculation, not growth investing.

Growth At a Reasonable Price (GARP) is a genuine, if to my mind odd, growth variation. Typically, a GARP investor sets a maximum PE ratio, say 25x the earnings likely over the next 12 months, as a maximum price he will pay for any stock, no matter how good the growth prospects. I’ve sometimes been described as a GARP investor, rather than a “pure” growth disciple. I find GARP too rigid, however. For instance, holding firm to 25x would have ruled out Apple for much of its growth period, even though the footnotes to the financials made it clear that the company was using extremely conservative accounting (since changed) to record the profits from its iPhone business.

I think genuine growth investing has four facets to it:

–the growth investor buys the stocks of companies he believes will grow earnings faster than the market expects and/or for a longer period than the market anticipates (hopefully, both)

–decisions must be based on meticulous analysis and projections of the financials of the company, done by the investor himself, at least in large part